Even strong stock market years can get very stressful 😱
Even strong stock market years can get very stressful 😱
Plus a charted review of the macro crosscurrents 🔀
Stocks declined last week with the S&P 500 shedding 1% to close at 5,204.34. The index is now up 9.1% year to date and up 45.5% from its October 12, 2022 closing low of 3,577.03.
After closing Q1 at a record high, the market kicked off Q2 last week on a sour note. The selling on Tuesday and Thursday had the S&P in a 2.1% drawdown from the March 28 record high.
If you do a Google search, you’ll have no trouble finding news stories backing into explanations for why markets moved the way they did. But trying to draw big conclusions based on the signal from a few days worth of market moves is often a futile exercise.
That said, it’s good practice to remember that the stock market will often fall on its way up.
Long-time TKer readers will recognize the chart below. It’s probably the most frequently shared chart in this newsletter. And for good reason! It’s my favorite visualization of short-term stock market performance.
(Note: If you’re tired of seeing this chart, then that’s probably a good thing. It means that you know the stock market sees lots of volatility, even in years when prices close higher. And just so we’re clear, I plan to keep sharing this chart in future newsletters just as I have in the past. After all, it speaks to TKer Stock Market Truth No. 2. More here, here, here, here, and here.)
Going back to 1980, this chart from JPMorgan’s Guide To The Markets shows each year’s annual return for the S&P 500 in gray and its intra-year max drawdown (i.e., the biggest sell-off from its high of the year) in red. During this period, the S&P has seen an average annual max drawdown of 14% while ending positive in 33 of the 44 years measured. This means that in most years, the market has more than recovered the losses experienced in the max drawdown.
So far, we’ve had a 2% max drawdown in 2024, which is historically modest. That is to say, we would need a much uglier selloff for this year to be average.
Does it matter that Q1 was so strong? The S&P 500 gained 10.2% during the period. Unusual strength must be followed by unusual weakness, right?
Truist’s Keith Lerner took a closer look at the 11 times since 1950 the S&P gained more than 10% in Q1. The average max drawdown during the remainder of the year for this sample was 11%. That’s not so bad.
Importantly, Lerner also observed that despite the drawdowns, the S&P ultimately registered further gains for the year 10 out of 11 times with an average return of 11%
All that said, there’s no example in the samples above where the max drawdown was as small as 2%. So we should be prepared for worse.
Zooming out 🔭
There are lots of things that may be driving uncertainty and volatility in markets right now, including heightened geopolitical tensions, rising energy prices, and the prospect for higher-for-longer interest rates amid tight monetary policy.
There’s also the issue of it being a presidential election year, which tends to come with heightened volatility before we get more clarity.
Some of these concerns will recede. Some may intensify.
As these narratives evolve, you can expect stock prices to swing.
But this is what investing in the stock market is all about. Volatility is the price investors pay for higher returns.
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Related from TKer:
Reviewing the macro crosscurrents 🔀
There were a few notable data points and macroeconomic developments from last week to consider:
👍 The labor market continues to add jobs. According to the BLS’s Employment Situation report released Friday, U.S. employers added 303,000 jobs in March. It was the 39th straight month of gains, reaffirming an economy with robust demand for labor.
Total payroll employment is at a record 158.1 million jobs, up 5.8 million from the prepandemic high.
The unemployment rate — that is, the number of workers who identify as unemployed as a percentage of the civilian labor force — declined to 3.8% during the month. While it’s above its cycle low of 3.4%, it continues to hover near 50-year lows.
For more on the labor market, read: Labor market: How cool will it get? 🥶
📉 Wage growth stays cool. Average hourly earnings rose by 0.3% month-over-month in March, down from the 0.2% pace in February. On a year-over-year basis, this metric is up 4.1%, the lowest rate since June 2021.
For more on why the Fed wants wage growth to cool, read: A key chart to watch as the Fed tightens monetary policy 📊
💼 Job openings tick higher. According to the BLS’s Job Openings and Labor Turnover Survey, employers had 8.76 million job openings in February, up from 8.75 million in January. While this remains elevated above prepandemic levels, it’s down from the March 2022 high of 12.03 million.
During the period, there were 6.46 million unemployed people — meaning there were 1.36 job openings per unemployed person. This continues to be one of the most obvious signs of excess demand for labor.
For more on job openings, read: Were there really twice as many job openings as unemployed people? 🤨
👍 Layoffs remain depressed, hiring remains firm. Employers laid off 1.72 million people in February. While challenging for all those affected, this figure represents just 1.1% of total employment. This metric continues to trend below pre-pandemic levels.
Hiring activity continues to be much higher than layoff activity. During the month, employers hired 5.83 million people.
For more on why this metric matters, read: Watch hiring activity 👀
🤔 People are quitting less. In February, 3.48 million workers quit their jobs. This represents 2.2% of the workforce, which is below the prepandemic trend.
A low quits rate could mean a number of things: more people are satisfied with their job; workers have fewer outside job opportunities; cooling wage growth; productivity will improve as fewer people are entering new unfamiliar roles.
For more, read: Promising signs for productivity ⚙️
📈 Job switchers still get better pay. According to ADP, which tracks private payrolls and employs a different methodology than the BLS, annual pay growth in March for people who changed jobs was up 10% from a year ago. For those who stayed at their job, pay growth was 5.1%.
💼 Unemployment claims tick higher. Initial claims for unemployment benefits rose to 221,000 during the week ending March 30, up from 212,000 the week prior. While this is above the September 2022 low of 182,000, it continues to trend at levels historically associated with economic growth.
For more, read: Labor market: How cool will it get? 🥶
💳 Card data suggests spending is holding up. From JPMorgan: “As of 27 Mar 2024, our Chase Consumer Card spending data (unadjusted) was 2.3% above the same day last year. Based on the Chase Consumer Card data through 27 Mar 2024, our estimate of the U.S. Census March control measure of retail sales m/m is 0.47%.“
From Bank of America: “Total card spending per HH was up 4.7% y/y in the week ending Mar 30, according to BAC aggregated credit & debit card data. Retail ex auto spending per HH surged at 5.2% y/y in the week ending Mar 30.”
For more on what’s bolstering personal consumption activity, read: Consumer finances are somewhere between 'strong' and 'normal' 💰
👎 Services surveys signal growth is cooling. From S&P Global’s March U.S. Services PMI: “The U.S. service sector reported a further rise in business activity in March, adding to signs that the economy enjoyed robust growth in the first quarter. Combined with an acceleration of growth in the manufacturing sector, the latest services PMI data point to GDP having risen at an approximate 2% annualized rate in the first three months of the year.“
The ISM’s March Services PMI also signaled growth, albeit cooling growth.
🏭 Manufacturing surveys look good. From S&P Global’s March U.S. Manufacturing PMI: “A key development in recent months has been the broadening-out of the upturn from services to manufacturing, with reviving demand for goods driving the fastest increase in factory production since May 2022. Jobs growth has also picked up as firms boost capacity to meet demand. Rising capex spending has likewise buoyed orders for machinery and equipment, in a further sign of firms gaining confidence in the outlook.“
The ISM’s March Manufacturing PMI also signaled growth with new orders and production showing significant improvements.
It’s worth remembering that soft data like the PMI surveys don’t necessarily reflect what’s actually going on in the economy.
For more on this, read: What businesses do > what businesses say 🙊
🔨 Construction spending ticks lower. Construction spending declined 0.3% to an annual rate of $2.1 trillion in February.
🏡 Newly built homes are getting smaller. From Apollo Global’s Torsten Slok: “The median size of new single-family homes peaked at 2,473 square feet in 2016. Today, the size of new homes being built is 2,237 square feet.“
🏠 Mortgage rates tick higher. According to Freddie Mac, the average 30-year fixed-rate mortgage rose to 6.82% from 6.79% the week prior. From Freddie Mac: “Mortgage rates showed little movement again this week, hovering around 6.8 percent. Since the start of 2024, the 30-year fixed-rate mortgage has not reached seven percent but has not dropped below 6.6 percent either. While incoming economic signals indicate lower rates of inflation, we do not expect rates will decrease meaningfully in the near-term. On the plus side, inventory is improving somewhat, which should help temper home price growth.”
For more on mortgages and home prices, read: Why home prices and rents are creating all sorts of confusion about inflation 😖
⛽️ Gas prices rise. From AAA: “Despite ominous overseas news, a pop in domestic gasoline demand, and oil prices rising to the mid-$80s per barrel, the national average for a gallon of gas climbed just three pennies to $3.56 since last week.”
For more on energy prices, read: The other side of the oil price story 🛢
⛓️ Supply chain pressures loosen. The New York Fed’s Global Supply Chain Pressure Index — a composite of various supply chain indicators — ticked lower in March and remains near levels seen before the pandemic. That's way down from its December 2021 supply chain crisis high.
For more on the supply chain, read: We can stop calling it a supply chain crisis ⛓
🇺🇸 Most U.S. states are still growing. From the Philly Fed’s February State Coincident Indexes report: "Over the past three months, the indexes increased in 43 states, decreased in three states, and remained stable in four, for a three-month diffusion index of 80. Additionally, in the past month, the indexes increased in 35 states, decreased in six states, and remained stable in nine, for a one-month diffusion index of 58.”
📈 Near-term GDP growth estimates look good. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 2.5% rate in Q1.
For more on economic growth, read: Economic growth: Slowdown, recession, or something else? 🇺🇸
Putting it all together 🤔
We continue to get evidence that we are experiencing a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
This comes as the Federal Reserve continues to employ very tight monetary policy in its ongoing effort to get inflation under control. While it’s true that the Fed has taken a less hawkish tone in 2023 and 2024 than in 2022, and that most economists agree that the final interest rate hike of the cycle has either already happened, inflation still has to stay cool for a little while before the central bank is comfortable with price stability.
So we should expect the central bank to keep monetary policy tight, which means we should be prepared for relatively tight financial conditions (e.g., higher interest rates, tighter lending standards, and lower stock valuations) to linger. All this means monetary policy will be unfriendly to markets for the time being, and the risk the economy slips into a recession will be relatively elevated.
At the same time, we also know that stocks are discounting mechanisms — meaning that prices will have bottomed before the Fed signals a major dovish turn in monetary policy.
Also, it’s important to remember that while recession risks may be elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs, and those with jobs are getting raises.
Similarly, business finances are healthy as many corporations locked in low interest rates on their debt in recent years. Even as the threat of higher debt servicing costs looms, elevated profit margins give corporations room to absorb higher costs.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have had a pretty rough couple of years, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »
TKer’s best insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
10 truths about the stock market 📈
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
The makeup of the S&P 500 is constantly changing 🔀
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks.
The key driver of stock prices: Earnings💰
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
Stomach-churning stock market sell-offs are normal🎢
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
High and rising interest rates don't spell doom for stocks👍
Generally speaking, rising interest rates are not welcome news for the economy and the stock market. They represent higher financing costs for businesses and consumers. All other things being equal, rising rates represent a hindrance to growth. However, the world is complicated, and this narrative comes with a lot of nuance. One big counterintuitive piece to this narrative is that historically, stocks have actually performed well during periods of rising interest rates.
How stocks performed when the yield curve inverted ⚠️
There’ve been lots of talk about the “yield curve inversion,” with media outlets playing up that this bond market phenomenon may be signaling a recession. Admittedly, yield curve inversions have a pretty good track record of being followed by recessions, and recessions usually come with significant market sell-offs. But experts also caution against concluding that inverted yield curves are bulletproof leading indicators.
How the stock market performed around recessions 📉📈
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
In the stock market, time pays ⏳
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
What a strong dollar means for stocks 👑
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
Economy ≠ Stock Market 🤷♂️
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
Stanley Druckenmiller's No. 1 piece of advice for novice investors 🧐
…you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.
Peter Lynch made a remarkably prescient market observation in 1994 🎯
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Warren Buffett's 'fourth law of motion' 📉
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
Most pros can’t beat the market 🥊
According to S&P Dow Jones Indices (SPDJI), 59.7% of U.S. large-cap equity fund managers underperformed the S&P 500 in 2023. As you stretch the time horizon, the numbers get even more dismal. Over a three-year period, 79.8% underperformed. Over a 10-year period, 87.4% underperformed. And over a 20-year period, 93% underperformed. This 2023 performance follows 13 consecutive years in which the majority of fund managers in this category have lagged the index.
The sobering stats behind 'past performance is no guarantee of future results' 📊
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. For example, 318 large-cap equity funds were in the top half of performance in 2020. Of those funds, 39% came in the top half again in 2021, and just 5% were able to extend that streak through 2022. If you set the bar even higher and consider those in the top quartile of performance, just 7% of 156 large-cap funds remained in the top quartile in 2021. No large-cap funds were able to stay in the top quartile for the three consecutive years ending in 2022.
The odds are stacked against stock pickers 🎲
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 24% of the stocks in the S&P 500 outperformed the average stock’s return from 2000 to 2022. Over this period, the average return on an S&P 500 stock was 390%, while the median stock rose by just 93%.
